The highly anticipated Saudi Aramco initial public offering has now been delayed until 2019 at the earliest. While it may initially seem unrelated, this is probably another strong signal for a lower dollar and higher inflation through the rest of the decade. Here’s why.
First, the reason for the delay is likely Saudi Crown Prince Muhammad bin Salman’s intention to try to further raise oil prices by crimping the supply out of OPEC so his future IPO market cap can reach his desired $2 trillion target.
For that number to come even close to fruition and as I calculated last year, oil would have to be higher than $100 a barrel. Hundred-dollar oil could get the Saudi Aramco IPO to about $1.5 trillion, which would save face for the Saudis at least. This number takes into account average price-to-revenues ratios of the top three oil companies: ExxonMobil Corp (XOM, Financial), Royal Dutch Shell PLC (RDS.A, Financial) and Chevron Corp. (CVX, Financial). Factor in the lower cost of production per barrel in Saudi Arabia, and $100 is the general target.
Bin Salman may publicly be aiming for $2 trillion, but it is doubtful he can raise the price of oil high enough to get there. Hundred-dollar a barrel is still very high, though it is at least conceivable. Any higher would be unrealistic without a significant move down in the dollar index (UUP, Financial).
Now, the 2014 oil collapse comes down to basic economics of supply and demand, metrics that have not changed all that much since. U.S. oil production nearly doubled from 2008 to the end of 2014 and has since reached new all-time monthly records of over 308,000 barrels a month due to the advent of new technologies for extracting shale and better drilling technologies. Those technologies have by no means disappeared. If anything, U.S. oil companies have gotten even more efficient at oil extraction since the great cull of 2015 and 2016 that saw a wave of bankruptcies in the energy sector as the oil price dropped to $26 a barrel.
That means as soon as oil prices reach a sustained range where it is profitable for U.S. companies to drill more and they feel confident that the price will not collapse again, they will start drilling again and production will ramp back up. This will create downward supply side pressures on the oil price that will prevent it from rising too high.
On the other hand, there is Bin Salman and OPEC who want to push the oil price as high as they can get it, and they will continue to constrict supply for as long as they can without harming their market share irreparably, at least in their estimation.
A meeting between the Saudi Crown Prince and President Trump is scheduled for March 19. At the meeting, the price of oil will almost certainly be a topic of conversation. Given the record amount of oil production by U.S. companies and the Saudi desire to see oil prices as high as possible, the U.S. and Saudi Arabia likely share similar goals for the price of oil. Trump as a mercantilist wants to see a more even trade balance and exporting oil is a good way to realizing that goal.
So where does inflation come in? While Trump and Bin Salman may both be very powerful, they still cannot overcome basic economics. The market has always been and always will be stronger than any political power, since the latter in the end depends on the strength of the former.
Given the balancing forces influencing the oil price, there is only one way for oil to reach $100 or more by the end of 2019, and that is a significant weakening of the U.S. dollar. If the dollar weakens, the price of oil priced exclusively in dollars could nominally reach $100, but that would also mean significant inflation across the U.S. economy as well. Could Trump and Bin Salman then be sharing a goal of a weaker dollar through 2019? If so, the prospect of higher inflation becomes even more likely as the decade closes out. Keep in mind that in order to finance the enormous deficits that Trump has baked into the budget, a weaker dollar may be necessary as well.
Disclosure: Long CVX.
